In a fiat currency system , which system is now used by almost all money-creating jurisdictions in the world (including the UK, USA and eurozone) all that money represents is a promise to pay, which is otherwise called debt. All money creation must, as a result, recognise the creation of new debt between the parties who give rise to that new money creation.
This process is not as complicated as it sounds. Only two types of organisation can be involved in transactions that create money.
We’ve just defined money as debt. Therefore anyone who creates a debt is creating money.
Standing in a pub in Downham Market – for those legally able to do so – with two friends. Not a full session, but a throat washer. Say, three pints each. Accountant number 1 buys three pints, one for each person present.
We all know that in British social circles this has just created a debt. May not really be callable but it is societally enforced – try not standing your round for a week or two and you’ll not be part of either rounds or even the conversation any more.
15 minutes later, accountant number 2 buys three pints. That creates more debt. The money supply has increased. But also reduced, for he has stood his part of his round to accountant 1 (no, they’re accountants, they do not have names, just numbers). And then the final round of the round – as it were – and our money supply collapses down to where it was at the start. There are no outstanding debts between our three accountants as each has stood his round.
Now, yes, this is trivial in one sense. Rounds aren’t really tradeable but they are those socially and societally enforced debts. Increasing the number of them is indeed increasing our money supply given that we’ve defined money creation as debt creation.
Which is the point that the ‘Tatercounant has got wrong. If indeed it is true that the creation of debt creates money, that money creation is debt creation – and as a useful manner of viewing the world we’re fine with that definition – then anyone who creates debt is creating money.
We don’t only have two people creating debt in our society. Therefore we don’t only have two people creating money.
We could tighten up our definition of course. We could, say, insist that only governments or banks create the right sort of debt which is money, or money which is debt. But then our insistence that only two people do create money is driven purely by our definition, it’s not an outcome of the logic of the situation at all.
Don’t like that pubs and rounds explanation? Running a tab anywhere increases the money supply for the length of time of the tab. Your restaurant bill increases the money supply as you munch through the starters, grapple with the Sancerre, move onto the claret and the beef and then collapses back down again as you settle up. Or the 17th century habit of private money as Charles II and so on were too cheap to mint copper coinage. Or the reason for the Truck Acts and corporate/employer money used to pay wages. Or paying your electricity bill 45 days in arrears as opposed to prepayment on a meter?
Yes, this is important. A high trust society where it’s possible to say “Catch you later on that” has a vastly different money supply from a low trust one where it’s cash on delivery or prepayment.
What matters in this form of money creation is whether people believe the promise to pay of course. We’ve even got an entire system of evaluating such claims – discounting a bill is exactly that.
And that’s only one of the problems with the ‘Tater’s ideas. His definitions are entirely circular. If indeed it is true that debt ios money, money is debt – which as I say is a useful view to illuminate certain parts of the economy – then anyone who creates debt, any act which creates debt, is also creating money. So, we cannot say that only banks and government create money because they are not the only two people who create debt.
If we do want to say that only banks and government create money then we have to accept that debt equals money, money equals debt, is not a usefully true definition within the insistence that we ourselves are making.
We can indeed say that only banks create bank money, only governments create government money. But that’s about as useful as insisting that only cats piss cat piss. Well, yes, and? We can’t mix and match our definitions so that micturation is the evacuation of urine and then go on, at the same time, that only cats piss piss. We must stick with the one or other definition within our same argument.
If money is debt then anyone creating debt is creating money, we do not have only two issuers. If we’ve only two issuers then we’re not talking about the equality of debt and money. Cat piss is indeed cat piss, but urine is produced by many other creatures as well.
The “promise to pay” schtick applies to promissory notes. The folding stuff you put in your pocket. Actual money is a token of value can be confidently exchanged for goods & services. It’s got FA to do with debt except in that matter of confidence to exchange. While you’re holding it it’s a placemarker for a future act of commerce.
I agree bis.
Of course if Murph went ahead and printed all the money he wanted to, no one’d have any confidence in it whatsoever.
So if the govt goes mad and adopts mmt and goes on a spending spree it raises government debt massively(and probably inflation as more spending than available resources) which has to reigned in by taxation. Seems a fuckwit way to ruin an economy.
Sure, My Aussie friend. And the further one moves away from money being a token of value in commerce, the more trouble you’re in Until you end up in the nonsense of MMT.
Think of Tim’s 3 guys in the pub scenario. At the point where #3 hasn’t bought his round. It’s an obligation in that commerce. Sure you can monetize it as debt for accountancy’s sake. Price of two beers. But guys 1 & 2 can’t take that obligation & exchange it for beer with the barman. He’ll have no confidence the beer will be paid for. So no actual money was created.
“But guys 1 & 2 can’t take that obligation & exchange it for beer with the barman. He’ll have no confidence the beer will be paid for. So no actual money was created.”
But if the third guy was a regular and asked for the next round to be put on his slate, the beer would be forthcoming, at least in many pubs I’ve been a regular in. Money is not so much debt as trusted debt, with discounts depending on (lack of) trust. See the Irish bank strike back whenever (70s? 80s?).
So if the govt goes mad and adopts mmt and goes on a spending spree it raises government debt massively(and probably inflation as more spending than available resources) which has to reigned in by taxation. Seems a fuckwit way to ruin an economy.
Surely you mean ‘when’ not ‘if’ the govt goes mad?
But Mr Cat, the obligation is not transferable outside that pub & its customers. The confidence is between them. What makes money money is the confidence is in the money itself, not who’s proffering it.
Something the MMT’ers are determined to destroy.
This is a transcript from a video by Professor Richard Werner where he explains banking:
[quote]
In reality, banks are creators of the money supply. They create money out of thin air. Most people think of banks as deposit taking institutions that lend money but the legal reality is that this is false. A deposit is not a bailment and is not held in custody. Legally, when you put money in the bank, it is not a deposit but simply a loan to the bank. The banks borrow from you the general public.
Banks don’t lend money either. Instead they purchase securities. If you sign a loan or mortgage contract with the bank you issue a security, namely a promissory note and the bank purchases that.
This is very different to what the banks present to the public.
So the bank purchases your promissory note but how do you get your money? No money is transferred, instead you will find the requested sum in your account. This is because, as mentioned above, what we all think of as deposits are actually the banks record of its debt to the public. Therefore, the record of what the bank owes you, is all you are getting when you receive a loan from them.
That is how the banks create the money supply. 97% of the money supply is created out of nothing when they lend because they invent fictitious customer deposits. How do they do this? They simply redefine the promissory note that they have purchased from you (your loan) as a customer deposit but in reality nobody has deposited any money.
By inventing these claims on themselves (the fictitious deposits), banks create the money supply. This can be positive for the economy as long as the money creation is in line with new goods and services or implementation of new technologies. This is adding value to the economy and is funded by this money creation. It also means no inflation, the loans can be serviced and repaid, you have a stable economy and low inequality.
[end quote]
Source to my comment above, with Werner’s video in the article:
Where all Conspiracies Begin and End – the Banking system creating Money out of Thin Air
https://nakedemperor.substack.com/p/where-all-conspiracies-begin-and
Yes, yes, well done. Now, please, cease this wankstain triviality around here.
More to the point, actually try answering the question. If banks don’t need deposits then why do they go bust when deposits leave?
“A deposit is not a bailment and is not held in custody. Legally, when you put money in the bank, it is not a deposit but simply a loan to the bank.” Golly, so a bank is not a mere vault! Did you ever! Somehow people in, say, the 19th century understood this without Werner’s help.
“Banks don’t lend money either. … If you sign a loan … contract with the bank …”: hold on! Bit of a contradiction there, isn’t there? Don’t loan contracts imply loans, i.e. imply lending? Let’s try again.
“Banks don’t lend money either. Instead they purchase securities. If you sign a loan or mortgage contract with the bank you issue a security, namely a promissory note and the bank purchases that.” I see. So if I lend money to an offspring who signs a promise to repay on demand I have not actually lent money even though we both view it as a loan. Crikey! What blind fools we’ve been. Does that mean that only loans that are not secured are true loans? Blimey O’Reilly! Or perhaps even loans that are not recorded? Stone the crows!
“how do you get your money? No money is transferred, instead you will find the requested sum in your account.” Eh; isn’t this a distinction without a difference? Once the money is in your account you withdraw it and, boom!, there you are, it’s been transferred.
This Werner stuff all sounds like the Higher Blethers to me.
“If banks don’t need deposits then why do they go bust when deposits leave?”
Because their assets have fallen in value, as you’ve correctly stated. Otherwise, there would be no problem. If the bonds had held their value, the bank could sell them and hand the money over to the depositors. The bank’s balance sheet would shrink, and their profitability would decrease, but that’s all that would happen. Then they could start making loans to expand it again.
Phoenix:
1) different names don’t change the underlying substance.
2) if banks don’t need deposits, why would their balance sheets shrink when deposits are withdrawn?
Dean Baker gets it.
[quote]
This brings us to the second point; this is Donald Trump’s bailout. The reason this is a bailout is that the government is providing a benefit that the depositors did not pay for. It also is, in effect, a subsidy to other mid-sized banks, since it tells their depositors that they can count on the government covering their deposits, even though they are not insured and the bank is not subject to the same scrutiny as the largest banks.
This is where the fault lies with Donald Trump. It was his decision to stop scrutinizing banks with assets between $50 billion and $250 billion that led to the problems at SVB.
Prior to the passage of this bill, a bank the size of SVB would have been subject to regular stress tests. A stress test means projecting how a bank would fare in various bad situations, like the rise in interest rates that apparently sank SVB.
If regulators had subjected to SVB to a stress test, they would have almost surely recognized its problems. They then would have required it to raise more capital and/or shed deposits.
[end quote]
Got that?.. You stress test and raise capital and/or shed deposits before the bad stuff happens.
dcardno,
Banks create deposits in the act of lending. They need to retain them after creating them because if the deposits leave, then their reserves decline. The bank then has to start selling off its assets.
A bank’s balance sheet expands when it makes a loan, and it contracts when the loan is being paid off.
Run the bank simulation below. Hit the “Issue $25 Loan” in the top right-hand corner and watch how the loan creates a new deposit and the balance sheet expands. You can do it more than once. Then hit the “Repay $25 of Loan” and watch as the balance shrinks. Play around with the other buttons too.
https://econviz.org/how-loans-create-money/#explore
Which was widely touted as a bipartisan piece of legislation. Maybe it was Fatcher…
I know how banking operates. And I know that MMT is a load of nonsense made up to justify the monetization of incontinent fiscal policy; that never ends well.
“This is where the fault lies with Donald Trump. It was his decision to stop scrutinizing banks”
Tit: Presidents don’t do legislation.
My comment about Dean Baker getting it was about the stress test, which is why I repeated it after the quote. I put the extra stuff in for context, not for the politics.
As an aside, I’m Canadian, so I don’t care for US politics, except insofar as the spillover effect into Canada. I can’t stand either of the two US political parties.
Hope that makes it clear.
But the stress test point is wrong. Greg Mankiw:
Contrary to the claims of some talking heads, the relaxation of Dodd-Frank in 2018 appears not to be a big part of the story. The “severely adverse scenario” in the regulators’ stress test did not include a major bond drawdown. Instead, it described a recession accompanied by falling interest rates. That is, the regulators would not likely have caught the imprudent bet the bank was making.
http://gregmankiw.blogspot.com/2023/03/five-observations-on-svb.html
Not that stress test. Do it like we do it in Canada instead.
OSFI is Canada’s banking regulator. This is from their website (note that they stress test for interest rate changes both up and down):
[quote]
8. Internal Management Stress Testing
Institutions are to simulate the impact on Net Interest Income (NII) and Economic Value of Net Assets (EVE) before tax arising from on-balance sheet and off-balance sheet items given a 1% (100 basis points interest rate shock. The amounts reported on lines 8(a) to (d) are to be based on the institutions’ own-estimate interest rate sensitivity positions as at the reporting date. Own-estimate sensitivities are to assume an immediate and sustained parallel change in interest rates across all maturities over the next twelve months, that no additional hedging is undertaken, and that all on-balance sheet and off-balance sheet items reprice by the interest rate shocks.
Institutions are to report the amount for both a 1% increase and decrease in interest rates.
This section does not apply to the foreign currency worksheet.
9. Guideline B-12 – Annex 1 Scenarios
Institutions are to apply OSFI Guideline B-12’s six prescribed interest rate shock scenarios to capture parallel and non-parallel gap risks for EVE and two prescribed interest rate shock scenarios for NII, for the consolidated, CAD, and US worksheet (if materiality thresholds are met). Institutions are not required to report the scenario results on the foreign currency worksheet.
The EVE amounts reported on lines 9(c) to (h) are to be expressed in present value terms. In order to accommodate heterogeneous economic environments across jurisdictions, the shock scenarios reflect currency-specific absolute shocks as specified in Table 1 in OSFI Guideline B-12.Footnote 1
Parallel shock up;
Parallel shock down;
Steepener shock (short rates down and long rates up);
Flattener shock (short rates up and long rates down);
Short rates shock up; and
Short rates shock down
Institutions are to simulate the shocks independent of each other.
[end quote]
As you can see from the above in the latter part that describes shocks, it’s quite comprehensive in terms of the scenarios they test for. Here’s the source with more of the stress test:
https://www.osfi-bsif.gc.ca/Eng/fi-if/rtn-rlv/fr-rf/dti-id/Pages/I3.aspx